Debt Research Bankof America 2 Creait strategy February 28, 2007 Credit Default Swap Primer Third Edition Glen Takst Figure 1, Estimated Growth n Sing Name CDS Notional Generis 10,000 Dette Staley 8,000 6,000 4,000 2,000 : E g & & ‘$Billions. | 2002 Hl 1997 | 1998 | 1998 | 2000 2001 20061 TT D> The rapid growth of the eredit default swap (CDS) market now places it at portf mayer’s vestment opportunity set. rly days of providing a vehicle for bank loaa portfolios to hedge eredit exposures, the CDS market has moved into the Additional Authors ‘mainstream of credit portfolio management. Hedge funds, mutual funds, pension Joftey A. Roseaberg fimels and insurance companies now access the CDS market, rounding out the eae base of users from banks and dealers etn ssenbrttaceies som > Issuer representation in the credit default swap market Is evolving from Head of rae Sins Rese purely high grade into high yicld, providing new tools for traditional high Ward Bortz yield inyestors and new credits for traditional CDS investors. We discuss 2n2st0 aust Teatures relevant to the growing high yield CDS market, including the indices, ward nottasces con conversion between dollar price and spread, and the meaning of points upfront. Cet Dette Stet > New to the third edition! Second-generation CDS products allow investors to Mingsung Tang reference more than just corporate bonds. Leverazed loan CDS and secured aiaaaranns CDS let investors trade across the capital structure, while CDS on ABS references ingeng tangents a subprime montages. We look for expansion of new entrants to the CDS market, Port States including CDS on CDOs, preferred, accounts receivable, and private placements Xiaodong Zhu > We greatly expand our diseussion of how LBOs and spinoffs affeet CDS. 2917947 5489 contracts through Succession language. We also analyze negative basis trades, veniatescirescan CDS settlement protocols, and the details behind CDS market surveys Porto States This report has been prepared by Banc of America Securities LLC (BAS), member NYSE, NASD and SIPC. BAS is a ‘subsidiary of Bank of America Corporation. This report is intended for sophisticated institutional investors and equivalent professionals in the fixed income market only. Ploase soe tho analyst cor portant disclosures on page 154 of this report. BAS and its affiliates do and seck to do business with compar in their research reports. As a result, investors should be aware that the firm may have a conflict of intorost that could affect the objectivity of this report. Should investors consider thie report ae a factor in making an investment decision, it must be considered as a single factor only. Confidential ‘TRB-0000011258 DCL Exhibit 1555Credit Strategy Research Bankof America 2 February 28, 2007 Table of Contents This primer is organized by importance, Readers who want a basic overview of CDS should focus on early sections, ““NEW" denotes new soctions in the third edition, “UPDATED” denotes soctions with significant updatos. Introduction to Credit Default Swaps The CDS Market: Size, Representation and Users. The Credit Derivatives Market. ‘The Impact of the Synthetic CDO Market NEW: Exchange Traded CDS. (CDS Structure: Contractual Terms, ISDA Definitions, Evolution and Experience. What Isa Credit Default Swap? DS Contract Terminology Differences Between the CDS and Corporate Bond Markets Pricing in the CDS Market. ‘The ABCs of Credit Spreads, ‘The Credit Default Swap Basis... NEW: Margin and Leverage. CDX and iTraxx Indices Key Features of CDX Indices. Plain Vanilla Trade Example—Counterparty Buys § 10mm CDX.NA.G Protection Credit Event Example: Counterparty Owns $ 10mm CDX.NA.G Protection Basis Between Intrinsic and the Index... nme NEW: Hedging Between Indices.. More Advanced Topics CDS Pricing and Analytics. €0S Rolls. Sample P&L Calculation Implied Probability of Default 8 NEW: Mind the Discount Factor 49 NEW: CDS Duration and Curve Trades 50 ‘The Transition from Spread to Points Upfront. 53 Assignments and Unwinds ‘Second-Generation CDS Products. NEW: Leveraged Loan CDS ("LCDS") NEW: Secured CDS. UPDATED: CDS on ABS .. NEW: CDS on CDOs NEW: Preferred CDS ("PCOS")... NEW: Accounts Receivable CDS NEW: Private Institutional CDS. ‘Appendix A: More on CDS and Corporate Bond Market Surveys. NEW: CDS Market Surveys. NEW: Corporate Bond Market [email protected] ‘Appendix B: Mote on the Structured Credit Markel The Correlation Crisis of May 2005. Introducing the Leveraged Super Senior. NEW: Constant Proportion Debt Obligations (CPDOs), ‘Appendix C: Sample Trader Runs, Confirms, and Documentation. 2 Credit Default Swap Primer Glon Takslor 212.933.2559, Confidential ‘TRB-0000011259Credit Strategy Research Bankof America 2 February 28, 2007 ‘Sample Trader Runs.. Sample Term Sheet fora Now Trade ‘Sample Request for an Assignment UPDATED: Sample Trade Recaps and Mechanics. ‘Sample Credit Event Documentation ‘Appendix D: Succession—How LBOs and Spinoffs Affect Credit Derivatives. UPDATED: Main Issues Surrounding Succession . NEW: Sucoession in 2006 and 2007 NEW: Operational Issues Surrounding Succession Events. Appendix E: CDS Settlement Protocols NEW: Basic Cash Settlement Auction Mechanics. NEW: How to Physically Settle a Trade. NEW: Determining the Final Price ‘Appendix F: The Finer Details of CDS Contracts . UPDATED: Credit Events : ‘Three Types of Obligations in a CDS. Settlement von tne Case Histories: The Impact of Market Events on the Development of the CDS Market 120 ‘Appendix G: Addendum to the ABCs of Credit Sproads ‘Par Floater and the Perfect Hedge. Getting to a Floater from a Fixed Rate Bond: The Par Asset Swap. Appendix H: Mathematics of Par CDS Equivalent and Asset Swap Spreads, UPDATED: How to Calculate Par CDS Equivalent Spread... ‘The Mathematics of Asset Swap Spreads Appendix I: Analyzing Negative Basis Trade NEW: Overview: NEW: Results| Appendix: CDS Operational Concerns. Main Documents. é Required Documentation NEW: Electronic Settlement of Trades (OTCC) and COS Trade Warehouse Give Ups. Appendix K: More on the CDX Inc Index Composition Rules Index Rolls, Credit Events in the COX indices. ‘Succession Events in the CDK Indices... Reference Entities in the CDX Indices Appendix L: More on Single-Name CDS Rolls, Appendix M: More on Points Upfront. How to Convert from Spread to Points Upfront. Breakeven Between Running Spread and Points Upfront, Credit Default Swap Primer Glon Taksler 212.933.2559 Confidential ‘TRB-0000011260Credit Strategy Research Bankof America 2 February 28, 2007 The CDS Market: Size, Representation and Users The Credit Derivatives Market While the precise size of the credit derivatives market is not known, itis clear that the market has grown and gained significant strength in recent years. Figure 2 provides a sense of the growth in notional volume of credit default swaps (CDS) since 1997, relative to the corporate bond market Figure 2. Estimated Growth in Single Name and Total CDS Notional, Globally {Single Name CDS Novona-Etimatos ‘Total COS Novonal-Estimates {Cash Notona-ésimaras 28,000 24,000 2 20:00 8 6000 B 12000 * 8000 ‘oe 9a > lh aarti srl See a ee ee Cento eastern mbes wt eset test npn nomen at ob US mace Ne ou en te ISDA’s 2006 midyear ISDA’s 2006 mid-year market survey estimates that CDS notional grew by $2% in the market survey estimates first half of 2006, to $26 trillion. This figure is more than double a f that CDS notional grew estimate of $12.4 trillion. According to the British Bankers Association, credit default by noarly 52% in tho first ‘Wap use is expected to continue growing at approximately 30% per annum. Although half of 2006, to $26 single-name CDS has the greatest market share by product, the overall influence of trillion indices and structured credit products is growing rapidly: 4 Credit Default Swap Primer Glon Takslor 212.933.2559, Confidential ‘TRB-0000011261Credit Strategy Research February 28, 2007 Bankof America 2 Figure 3. CDS Product Usage, 2003 Figure 4. CDS Product Usage, Forecast 2008 er Basar HOE RE Opts et ONS * Tet etm pode, 8 Oye Ey kad coat Oe a ps ods creates ee % 1 rates cos et he * a rates — ow it Singeoare Yona 5 10% tne 51% ~~ toe sia Tete) spate hes Ca oe coos Trance) oi 16% oo The singlename cos market is estimated at ‘$85 tllon for midyear 2008 About 57% of high grade Issuers trade actively in the CDS market, accounting for 85% of ‘market debt Confidential Based on the overall CDS market size shown in Figure 2, this pegs the size of the single-name CDS market at $8.5 trillion for mid-year 2006, compared with S18 trillion in 2003. The synthetic CDO market grew to an estimated $4.2 tnllion in 2006, from 9570 billion in 2003, and the index market grew to an estimated $7.8 trillion in 2006, from $319 billion in 2008. (The CDX credit derivatives indices began trading in October 2003.) In general, we agree that the CDS market is growing rapidly. But, we emphasize that under many circumstances, the size of the CDS market may grow without any change in overall risk exposure. For example, if an investor buys protection in an index and sells protection in each of the underlying constituents, reported CDS notional will grow, even though net credit exposure will be unchanged. For moze details on the methodology of CDS market surveys, please see Appendix A: More on CDS and. Conporate Bond Market Surveys. DS Issuer Composition igh Grade Credit default swaps are actively traded on corporate, bunk and sovereiun debt Approximately half of the total trading volume is tied to vorporate naznes, while the remainder is split between financial und sovereign credits. Trading activity in corporate and financial names is greatest for five-year contracts, but is also significant for two three-, seven- and ten-year maturities, In high grade names, we estimate that about $7% of total high grade issuers trade actively in the CDS market, Since these issuers are concentrated in the larger, more liquid credits, they account for approximately 85% of the market on a debt outstanding Weighted basis. This represents a very liquid market, as cash market investors are Well aware that a significant number of issuers in that market have large debt issues that trade infrequently. ler representation Credit Default Swap Primer 5 Glon Taksler 212.933.2559 ‘TRB-0000011262Credit Strategy Research February 28, 2007 Figure 5. High Grade Liquid CDS Issuers vs. High Grade Cash Issuers, Estimate as of Fabrary 2007 Bankof America 2 Basi Matoals 2 Capita Goods - Manufacturing 24 consumer Cyeia 2 Consumer Hen yeh 26 rey 2 Finance Gaming, Lodging &tesure 4 Heath Care 24 Insurance 2 Mea 14 Technology 12 Telecommuricaions 18 Trenspotaton 10 uilies 26 Total 317 39 2 40 40 560 54% 57% 13% 65% 53% 446 80% 739% 70% 87% 75% 71% 46% 51% 708% 20% 20% 20% 17% 88% 96% 87% 20% 939% 58% 98% 20% 16% 85% High Yield We estimate that approximately 13% of hi About 13% of high yield Issuers trade actively in the CDS market, accounting for 42% of cash bond market value, Figure 6 illustrates this point mae th bond market value. Figure 6 illustrates this point. 6 Credit Default Swap Primer Glon Takslor 212.933.2559, Confidential h yield issuers trade actively in the CDS smarket. While this figure is not as large ay in high grade, these issuers repress of the high yield market's largest names, Therefore, based on market weight outstanding, high yield CDS accounts for approximately 42% of the high yield total wtsome ‘TRB-0000011263Credit Strategy Research Bankof America 2 February 28, 2007 Figure 6. High Yield Liquid CDS Issuers vs. High Veld Cash Issuers Estimate as of Fabraary 2007 Basi Matfals 20 120 11% 22% Capita Goods - Manufacturing 7 a7 6% 345 Consumer Cea 18 139 139% 28% Consumer Hen yeh a 6 11% 51% rey 8 "7 109% 50% Finance 49 6% os Gaming, Lodging &tesure 3 61 5% 39% Heath Care 4 a 9% 53% Insurance 2 6 33% 70% Mea 10 16 139% 20% Technology 22 28% Telecommuricaions 8 38 22% 62% Trenspotaton ° v7 0% om uilies 2 80% 85% Total 118 13% 42% Breakdown of Buyers and Sellers of Protection Banks and dealers are To date, banks and dealers have been the dominant CDS players as both Buyers and both Buyers and Sellers Sellers of eredit default protetion. Banks’ prominence as protection Buyers isin part a of protection natural outgrow oftheir dosire to hedge their substantial credit exposure, and as Sellers out of increased ROE focus and desire to diversify credit exposure. As market makers, broker-dealers generally run more evenly balanced trading books, but are becoming more active in managing their portfolios of credit risk, leading to increased participation as Buyers of protection. This relative dominance is expected to diminish ‘in coming years, as the use of credit derivatives by other institutional participants grows. Credit Default Swap Primer 7 Glon Taksler 212.933.2559 Confidential ‘TRB-0000011264Credit Strategy Research Bankof America 2 February 28, 2007 Figure 7. Sellers of Protection, 2006 Figure 8. Buyers of Protection, 2006 Pension funds Comps: Me. Insurers Mutual nds Penson ands Nuwatunds TR om a ie 3 < a Ge ace sank an trang ne ets Cre Som ees) vege ts oo si Nod “ee won hanes ene loan 18% = Pontes Insrers tend to be net Insurers tend wo be net Seles of preecton The ed for yield has Hed 0 patipaton Salers of protection in the credit derivatives market trovigh selling protection on singlesneme and tanched CDS. Basker rades allow insurers to pick up spread for a given rating category relative {to cash or other structured (ABS) altematives. Hedge funds also have emerged as large Buyers and Sellers of protection, and are now Hodge funds are the the fastest growing participants in this rapidly expimding market. The overall position fastest growing inthe CDS market grew fom about 15% in 2003 to 30% in 2006, with a focus onthe bartepants Tiskiest parts ofthe eapita structure. Moreover, hedge funds are typically total return investor, contributing toa general perception that CDS has higher volatility than the corporate bond market, Hedge funds have two main motivations for participating in the CDS market: the opportniy to use dramatically higher leverage than other markets allow, and relative vale between CDS and cash Credit Derivative Product Companies (CDPCs) are perhaps the newest class of ‘credit Derivative Product Companies (CDPCs) are protection Sellers. CDPCs are triple-A rated investment vehicles that sell protection, perhaps the newest class primarily on investment grade credits. Due to their high rating, CDPC% are exempt Tena Sens from initial margin requirements, and therefore able to use leverage to seek high oF protection Seles retums. Equity, in the form of common stock, provides a cushion for potential loss of principal on the credit portfolio. The Impact of the Synthetic CDO Market In genera, strong Synthetic demand has been a large catalyst toward tighter spreads since 2004. This smthetic demand has source of demand represents an important technical factor influencing credit default bboen a catalyst toward spreads through the issuance of synthetic collateralized debt obligations (CDOs), tighter spreads particularly in the form of single-tranche CDOs (STCDOs). STCDO issuance represents leveraged exposure to the credit risk of an underlying portfolio. In the STCDO market, dealers typically sell credit risk to the end investor through one particular tranche. Higher credit risk tranches, such as equity and mezzanine structures, have greater leverage. Dealers hedge their short credit risk exposure by selling protection in te single-name (secondary) CDS market. For example, $10 million in senior tranche exposure often results in $25 million of delta-hedging requirements on 8 Credit Default Swap Primer Glon Takslor 212.933.2559, Confidential ‘TRB-0000011265Credit Strategy Research Bankof America February 28, 2007 ‘the underlying reference notional.’ This leverage factor allows a small notioral position ina tranche to translate into a much larger market impact in terms of CDS notional ‘volume. Figure 9 gives a sense of the growth in the synthetic CDO market. Figure 9. Investment Grade Synthetic CDO Issuance January 2003-December 2006 25 20 18 10 z 2 3 Average monthly tailored single-tranche collateralized debt obligation (STCDO) volume, as measured here by distributed tranches excluding super seniors, hes surged to $12 to $15 billion from 2003°s $1 billion. One reason for the increased demand is the continued spread pickup in CDOs versus like-rated cash bonds, as highlighted in Figure 10. Figure 10. CDOs Spread Pickup to Cash Remains Catalyst for Market Growth Single 1077 CDOs versus Sing ate Spreads = 10y 000s singes) —-»-s —10y Corporate Sonds (Sines) 250 5 150 | t ° Dect Ju02 FebO3 Sep-03 fp-O4 NovO4 JurD5 Jar-00 Aug0G ‘Spread to UBOR (bps) spent inc aan emg ape Cd tc LG Gee mace “The et holga proprtin it fete of ie di calcuaons ro: he copula comcaion del seo pice and edge the traction Credit Default Swap Primer 9 Glon Taksler 212.933.2559 Confidential ‘TRB-0000011266Credit Strategy Research February 28, 2007 Bankof America 22> ‘More favorable accounting treatment and capital requirements should keep the synthetic market growing ‘The growth in STCDO volume translates into growth in CDS notional volume, as dealers use CDS to hedge the protection they have bought in the CDO market. As a result, the STCDO market represents an important new source of demand for the underlying single-name CDS market. Accounting Considerations Senior tranches, as leveraged investments, have significant mark-to-market risk, despite relatively low principal risk. Moreover, historically, for U.S. investors, mark-to-market ‘on credit derivatives has flowed through to net income, an on-balance sheet item, This standard has largely restricted synthetic CDO investment to non-U.S. investors. In January 2007, a new accounting standard took effect, Under FAS 155, it appears that the mark-to-market for syathetic CDOs (though not credit derivatives in general) will now flow through to shareholder's equity, thereby avoiding net income entirely, Consequeatly, the synthetic CDO market has seen an increase in U.S, investor appetite. Capital Requirements European STCDO demand also has been rising, on planning for Basel Il. Under Basel 1, capital requirements were the same across all ratings. Basel IT implements lower capital requirements for higher-rated credits, For example, requirements for double-A rated credits drop from 8% (under Basel 1) to just under 2% (under Basel II). Credits rated below BB- face more restrictive changes, with requirements increasing from 8% 0 12%. As such, a number of European banks are selling existing triple-B single-name positions, and buying exposure to double-A rated tranches. In many cases, the ‘underlying credits are the original triple-B rated single-names, but the tranche adds subordination to achieve a double-A rating, The Corelation Crisis: In structured credit, Wall Street carves up the risk of an underlying portfolio into a large relatively safe piece, concentrating the risk of the entire portfolio into a small slice of the overall portfolio. Based on sophisticated financial models, this small slice is held by dealers and hedge funds who attempt to hedge the risk. A large market shock, however, reveals thatthe assumptions underlying the models may have been accurate, resulting in not only a hedge ratio of the wrong size but one of the wrong sign, Vader FAS 185, cabotintion ot conser an embed derivative. The mare's interretation has heen ha accaustny exer fo ered ne ate, sue Guna special pacpe ently (SPE, wll tec Ue sae a a rein, and allow the sure oo thragh to et incre, the veto wold sed to wa SOs le taal nace, We yeu ao being we ine ak and spefaly proxi a in he FAS (aot act incr) To sot b ‘enplize but isis a cupurt bun. That i sureo-aret wo ow Cou sacle ely sateen, Those capital equcemens assume ws ofthe Sundaized apewac Base! Under aso ans will separated io Senda approach banks, Foundation cra Ratings Hass IRB) apache, Adesced Ratings Basel (AIRD) approach nk Bs adeping ire 0 fear eat ype yoy 207, las apg AID eee ay emt ay New a 10 Confidential Credit Default Swap Primer Gon Takslor 212.933.2559 ‘TRB-0000011267Credit Strategy Research February 28, 2007 Bankof America 22> ‘The correlation market ‘meltdown in May 2005 reminds us of a meltdown inthe CMO market more than a decade ago Sound familiar? The correlation market meltdown in May 2005 reminds us af a meltdown in the CMO market more than a decade ago. Then, misestimated prepayment ‘models led for example to positive durations on Interest Only strips, when they in fact ‘turned out to be negative, Dramatic changes in base correlation curves led toa similar result in May 2005. Mezzsnine-hedged equity strategies (long equity risk, short ‘mezzanine tisk) backfired, as spreads on equity tranches widened greater than model estimates while mezzanine tranche spreads actually tightened, even as spreads in the underlying portfolio widened, For more on the correlatio ‘market spreads, please see, isis, including the spillover effect on broader edit “Appendix: B: More on tie Struetured Credit Market.” The Synthetic CDO Buyer Universe At senior level attachment points, US and Buropean insurance companies, as well as banks, are Seliers of protection through STCDOs. Asian investors also are beginning (© access both US and European credit exposure through the synthetic structured eredit smarket, with senior level tranches, Down the capital structure, hedge funds are primarily Sellers of protection at the equity (frst loss) level. These strategies often reduce spread risk by buying protection at the mezzanine level, hedging with credit default index products, or hedging with single-name CDS.° NEW: Exchange Traded CDS In 2006, several proposals circulated for introducing credit default swaps traded on an. exchange. Broadly speaking, this product would be a fixed recovery swap that trades in present value terms. For example, rather than paying 100 bps running for five years, the protection Buyer would make a single upfront payment for te present value of the swap. Following a Credit Event, the protection Buyer would receive a fixed recovery rate, rather than the aetual recovery rate of the cheupest-to-deliver Bond or Loam Although we caution that this product has not yet started trading, Figure 11 summarizes ‘the major features of early proposals for exchange-traded CDS, versus over-the-counter cps. Nats tha psy evel da hedging on" xchangs” cael out he fir or (clin equvalent capa impact on eet spraads, snk higher capita stra pltes where investor expose remains unedget, Toate di equvaet expose ran sling poten on the ety anes lls by te Confidential Credit Default Swap Primer a Glon Taksler 212.933.2559 ‘TRB-0000011268Credit Strategy Research Bankof America 2 February 28, 2007 Figure 11. Oversthe-Counter CDS versus Proposals for Exchange Traded CDS North America Counterparty * Bank or Boker Dealer + Exchange Exeoute trade with + Bank or BokerDealer + Broter forthe change ‘Size +2 MM-5 MM + Contac of $100,000 Tenor + 1Year- 10 Yeas +5 Yeas Initial Price + Par + ParMinus Present Value of the Contact ‘quotation * Spread + Points Upfront (No Running) Coupon Payments + Quaterty = None ‘credit Events * Bankruntey, Failure t Pay, and Bankruptcy + For any debt obligation with forselected Reference Enttes, equal orhigher prionty of Modiied Restructuring payment tothe Reference Obligation: Default on interest, principal, or premium payments; oranother Event of Default as defined ty the tems ofthe debt obligation Redemption Event “N/A + Swap terminates eatl if no bt exists thats deliverable Ito a contact (2g. following a full tender) Maturity + 20th Day each of Mat, Jun, + 2nd Business Day preceding + 3nd Fiday of Contact Month, ‘Sep, and Dee the third Wednesday ofthe __inally proposed tobe Mr, Jun, Contract Month, intally proposed Sep, and Dec tobe Mar, Jun, Sep, and Dec Recovery + Floating (Determined by + Fhied at contact inception by + Zero Physical orCash Setderent) the entange Trading Hours + Overthe-courter Trading Day» Sunday Spm-Fiday 4pm, + Monday 8am- Friday 3pm, Chicago time Chicago time Margin Requirements Set by + Credit Suppor Annexwith Bank + Minimum standard setty exchange, but may be inceased by or BrokerDealer broker ‘Calculation Agent + Typlealy the Bank or Broker + Exchange Dealer unless both panies re Banle orSrokerDealers, in which case the protection Seller fh Cag: ean hen adit cet 2 Credit Default Swap Primer Glon Takslor 212.933.2559 Confidential ‘TRB-0000011269Credit Strategy Research February 28, 2007 Acrodit default swap isa bilateral contract for transfering credit risk The protection Buyer pays the protection Seller a quarterly premium for protection against adverse Credit Events on a tire party Reference Entity Unprecedented flexibility to manage credit risk Inherent limitations of cash instruments for expressing credit views Confidential Bankof America 2 CDS Structure: Contractual Terms, ISDA Defini Evolution and Experience What Is a Credit Default Swap? Ina credit default swap, one party (the protection Buyer) agrees to pay another party (the protection Seller) periodic fixed payments in exchange for receiving “Credit Event protection,” or a payment, should a third party (the Reference Entity) ot its obligations, suffer one or more pre-agreed adverse Credit Events over a pre-agreed time period. That is, credit default swaps are bilateral contracts used to transfer credit risk amo market participants, Figure 12 illustrates the mechanics of a credit default swap. Figure 12. Mechanics of a Credit Default Swap [Between trade nition and detault or matunty, protection ouyer makes regular payments of detault snap premium to protection seller. Periodic Fixed Payments ects Genes Following a crecit event, one ofthe following wil take place: (cash Satement Par~Firal Price oceesi ss Gece meses Physical Settlement aul Cass The financial innovation achieved by credit default swaps—and their primary atraction—is flexibility to manage credit risk. First, unlike other financial instruments, credit default swaps allow users to take unfunded eredit-only tisk positions (that is, independent of other market risks). Second, credit default swaps allow for customization of credit risk. Third, credit default swaps allow for efficient and confidential credit risk transfer. ‘Traditional cash instruments are inherently funding vehicles and, as such, represent inflexibly bundled market and credit risks. For example, investors in the cash markets ‘who are bullish on an issuer’s credit have to fund the investment and find a way to express their view among available loans and bonds in whichever maturities, seniority, etc. are available, In addition, investment in bonds or term leans can subject investors to cither undesited market risks or additional expense in hedging out this risk. These cash marker limitations are more accentuated when investors seek to express a bearish Credit Default Swap Primer a Glon Taksler 212.933.2559 ‘TRB-0000011270